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The IMF “In Principle” Approves Funding For Greece

In the FT, Mehreen Khan reports about the IMF’s conditional acceptance to lend to Greece.

The IMF’s “agreement in principle” (AIP) tool draws on a practice where the fund is able to greenlight its involvement in a debtor country, conditional on the government and its creditors agreeing to future debt relief measures.

Of course, the dispute about the merits of debt relief is unresolved. The IMF thinks Greek debt is ‘unsustainable’ and the European creditors should bear more losses, earlier on while some Euro area countries disagree. (For the numbers, see here).

Earlier in July, the European Stability Mechanism had approved a new cash injection (FT). This followed a dodgy compromise in June, as reported by Jim Brunsden in the FT:

Euro area ministers and the International Monetary Fund unveiled a deal … that will … sav[e Greece] … from default this summer. The IMF will join the bailout as a partner but withhold any money until euro area finance ministers give more detail on what debt relief they might offer Athens. …

Euro-area policymakers have been trying to reconcile competing EU and IMF visions of the €86bn programme and, crucially, whether it will make Greece’s debts sustainable.

Programme conditions set by euro area governments in 2015 included budget surplus targets that the IMF said were punishingly ambitious and unlikely to be met. The fund set out a different vision: lower primary surplus targets for Athens, coupled with comprehensive pension and tax reform and, crucially, far-reaching debt relief.

At the centre of the puzzle was Germany’s finance minister, Wolfgang Schäuble, who has insisted that the IMF must join if Greece is going to continue receiving tranches of bailout aid — but has also resisted significant debt relief commitments.

Given that the fund could not join up unless convinced that Greece’s debts were being put on to a sustainable path, the euro area and IMF had to find another solution — and it came in the form of asking Athens to do more.

To give the IMF confidence that Greece could hit budget surplus targets set by the euro area, Athens was asked to widen its income tax base and cut pensions. The measures, adopted in May, are estimated to be worth about 2 percentage points of gross domestic product.

In the meantime, Greece plans to regain market access by 2018 (FT).

Sources of Low Real Interest Rates

In a (December 2015) Bank of England Staff Working Paper, Lukasz Rachel and Thomas Smith dissect the global decline in long-term real interest rates over the last thirty years.

A summary of their executive summary:

  • Market measures of long-term risk-free real interest rates have declined by around 450bps.
  • Absent signs of overheating this suggests that the global neutral rate fell.
  • Expected trend growth as well as other factors affecting desired savings and investment determine the neutral rate.
  • Global growth was fairly steady before the crisis but may (be expected to) fall after the financial crisis. Recently, slower labor supply (demographics) and productivity growth may account for a 100bps decline in the real rate.
  • Desired savings rose, due to demographics (90bps), higher within country inequality (45bps), and higher savings rates in emerging markets following the Asian crisis (25bps).
  • Desired investment fell, due to a lower relative price of capital goods (50bps) and less public investment (20bps).
  • The spread between the return on capital and the risk-free rate rose (70bps).
  • These trends look likely to persist and the “global neutral real rate may settle at or slightly below 1% over the medium- to long-run”.

From page 2 of the paper:

See also the summary by James Hamilton; the White House CEA report; and the 17th Geneva report.

Does Greece Need Official Debt Relief?

In a Peterson Institute working paper, Jeromin Zettelmeyer, Eike Kreplin, and Ugo Panizza conclude that the answer to that question depends on your assumptions.

The authors compare several scenarios, including

  • scenarios A–C, the baseline scenario of the European institutions and two more pessimistic variants;
  • scenario I which underlies the IMF reasoning and which assumes that “Greece will not undertake the structural reforms needed to achieve higher potential growth”;
  • and scenario D, which corresponds to what Greece committed to when the third program was agreed, and which represents the German position.

They assume that interest rates on privately held debt rise with the debt-to-GDP ratio, and they use two “sustainability” metrics: The debt-to-GDP ratio (should fall), and gross financing needs as a share of GDP (should be smaller than 20%).

When running Monte Carlos simulations, the authors find that for each scenario, the assumptions about growth and primary surpluses are consistent with the conclusions drawn by the different institutions:

  • In A (borderline) and D, debt is “sustainable.”
  • Not so in B, C, and I, due to “accelerating substitution of official debt by more expensive borrowing from private sources”.

The authors then evaluate the plausibility of the scenario assumptions. They conclude that “international evidence does not support an adjustment path that envisages a primary surplus of above 3.5 percent for more than three to four years on a continuous basis and for more than seven years on an average basis” rendering B and C the most plausible scenarios, and suggesting that the debt is “unsustainable.”

In reaching their conclusions, the authors assume that primary surpluses in Greece will react to debt, inflation, and growth in line with the experience in other (developed) economies. (This means, for example, that surpluses rise as the debt burden increases, which seems to contradict the notion of debt overhang.) This is unconvincing, of course, if one takes the view underlying scenario D which presumes that feasible promises are kept. Or stated differently: Greece might well be able but not willing to pay—after all, in this very case official creditor intervention could have made sense in the first place although private lenders charged high interest rates. (With Harris Dellas, we make this argument precise in a paper in the Journal of International Economics.) Related, one can think of many reasons why the historical experience in other countries may be uninformative for the Greek case. The authors address one concern: They focus on episodes with very high debt-to-GDP ratios and find that in these cases, primary surpluses are maintained for longer. Moreover, there is the important question of measurement: The Greek debt-to-GDP ratio is not easily comparable with the ratio in other countries, see here and here, and most likely overstated.

Zettelmeyer, Kreplin, and Panizza make the case for a delay of Greece’s return to capital markets. In the conclusions, they write that

the debt relief measures put on the table by the Eurogroup in May 2016 could be sufficient to restore debt sustainability, but only if these measures are taken to an extreme. This means accepting an extremely long maturity extension of EFSF debts. In addition, it requires either substantial additional interest rate deferrals, or locking in significantly lower funding costs and hence lower interest rates than the EFSF currently expects, or a combination of both. While these measures are feasible within the red lines described by the Eurogroup, they are likely to be politically and/or technically difficult. Unless the EFSF manages to eke out substantial extra interest relief through creative long-term funding operations, its exposure to Greece will likely have to rise, possibly for decades, before it starts falling. A private sector creditor would not accept this type of restructuring because it gives the debtor country a strong incentive to default (or at least renegotiate) when the debt is at its peak.

… one way out of this dilemma would be to delay Greece’s return to capital markets, continuing to finance Greece through ESM programs until its private sector spreads are much lower than they are now. … this approach would lower the total need for debt relief and/or fiscal effort required to restore Greece to debt sustainability. While it would lead to a significant increase in official creditor exposure to Greece—requiring perhaps €100 billion of extra ESM financing—this is less than the rise in EFSF exposure that would be required in the Eurogroup’s approach, which aims to return Greece to private capital markets in 2018 while relying mainly on EFSF maturity extensions and interest rate deferrals … total official exposure to Greece would decline faster if ESM financing were to continue than if it were to end in 2018.

Importantly, they also point to the incentive effects of debt restructuring:

If [the threat of Grexit is essential to maintain incentives for reform] keeping the sword of Grexit … would help reduce debt levels only so long as Greece is being financed with cheap official funds. If, however, Greece returns to capital markets, any beneficial incentives of this approach would likely be offset by the risk premiums that private lenders would charge to a country whose euro membership remains at risk.

The official creditors will have to make up their minds: Not only the return on their lending is at stake, but also reform in Greece.

Kenneth Arrow’s Work

On VoxEU, Steven Durlauf offers an excellent overview over Kenneth Arrow’s work. Durlauf emphasizes five areas of research:

  • The impossibility theorem, in the tradition of Condorcet.
  • General equilibrium theory and the welfare theorems, in the tradition of Walras.
  • Decision-making under uncertainty, the Arrow-Pratt measures of risk aversion and contingent commodities.
  • Imperfect information, in the context of medical care and as a source of statistical discrimination.
  • Economics of knowledge, anticipating the endogenous growth literature.

Durlauf closes:

Like Faust, limitless curiosity and passion for knowledge meant that Arrow strove without relenting; but unlike Faust, Arrow needed no redemption. His intellectual integrity was pristine and unparalleled at every stage of his life. His character was as admirable and admired as his intellect. Arrow’s personal and scholarly example continues to inspire, nurture, and challenge.

Models Make Economics A Science

In the Journal of Economic Literature, Ariel Rubinstein discusses Dani Rodrik’s “superb” book “Economics Rules.” The article nicely articulates what economics and specifically, economic modeling is about. Some quotes (emphasis my own) …

… on the nature of economics:

[A] quote … by John Maynard Keynes to Roy Harrod in 1938: “It seems to me that economics is a branch of logic, a way of thinking”; “Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world.”

[Rodrik] … declares: “Models make economics a science” … He rejects … the … common justification given by economists for calling economics a science: “It’s a science because we work with the scientific method: we build hypotheses and then test them. When a theory fails the test, we discard it and either replace it or come up with an improved version.” Dani’s response: “This is a nice story, but it bears little relationship to what economists do in practice …”

… on models, forecasts, and tests:

A good model is, for me, a good story about an interaction between human beings …

A story is not a tool for making predictions. At best, it can help us realize that a particular outcome is possible or that some element might be critical in obtaining a particular result. … Personally, I don’t have any urge to predict anything. I dread the moment (which will hopefully never arrive) when academics, and therefore also governments and corporations, will be able to predict human behavior with any accuracy.

A story is not meant to be “useful” in the sense that most people use the word. I view economics as useful in the sense that Chekhov’s stories are useful—it inspires new ideas and clarifies situations and concepts. … [Rodrik] is aware … “Mischief occurs when economists begin to treat a model as the model. Then the narrative takes on a life of its own and becomes dislodged from the setting that produced it. It turns into an all-purpose explanation that obscures alternative, and potentially more useful, story lines”.

A story is not testable. But when we read a story, we ask ourselves whether it has any connection to reality. In doing so, we are essentially trying to assess whether the basic scenario of the story is a reasonable one, rather than whether the end of the story rings true. … Similarly, … testing an economic model should be focused on its assumptions, rather than its predictions. On this point, I am in agreement with Economics Rules: “. . . what matters to the empirical relevance of a model is the realism of its critical assumptions”.

… on facts:

The big “problem” with interpreting data collected from experiments, whether in the field or in the lab, is that the researchers themselves are subject to the profession’s incentive system. The standard statistical tests capture some aspects of randomness in the results, but not the uncertainty regarding such things as the purity of the experiment, the procedure used to collect the data, the reliability of the researchers, and the differences in how the experiment was perceived between the researcher and the subjects. These problems, whether they are the result of intentional sleight of hand or the natural tendency of researchers to ignore inconvenient data, make me somewhat skeptical about “economic facts.”

Douglas Adams’ “The Hitch Hiker’s Guide to the Galaxy”

In Douglas Adams’ book (volume one in the trilogy of four) we learn, among other things:

  • Towels are particularly useful for interstellar travelers on a shoestring.
  • It’s not clear whether humans conduct experiments on mice or vice versa.
  • The answer to Life, Universe, and Everything is “forty-two” as Deep Thought found after an extended period (seven and a half million years) of number crunching.
  • But what is the question? To find out, an even more powerful computer was built: The Earth. “Deep Thought designed the Earth, we built it and you lived on it.”
  • Unfortunately, the Vogons destroyed the planet just five minutes before the program was completed. The badly timed intervention was communicated as follows: “This is Prostetnic Vogon Jeltz of the Galactic Hyperspace Planning Council. As you will no doubt be aware, the plans for development of the outlying regions of the Galaxy require the building of a hyperspatial express route through your star system, and regrettably your planet is one of those scheduled for demolition. The process will take slightly less than two of your Earth minutes. Thank you.” And after some moments: “There’s no point acting all surprised about it. All the planning charts and demolition orders have been on display in your local planning department in Alpha Centauri for fifty of your Earth years, so you’ve had plenty of time to lodge any formal complaint and it’s far too late to start making a fuss about it now.”
  • Another artificial planet may be under construction. It might feature fjords as in Norway (on the original Earth), but this time in Africa.

See here or here for quotes from the book(s).

Money, Banking, and Dreams

In another excellent post on Moneyness, J P Koning likens the monetary system to the plot in the movie Inception, featuring

a dream piled on a dream piled on a dream piled on a dream.

Koning explains that

[l]ike Inception, our monetary system is a layer upon a layer upon a layer. Anyone who withdraws cash at an ATM is ‘kicking’ back into the underlying central bank layer from the banking layer; depositing cash is like sedating oneself back into the overlying banking layer.

Monetary history a story of how these layers have evolved over time. The original bottom layer was comprised of gold and silver coins. On top this base, banks erected the banknote layer; bits of paper which could be redeemed with gold coin. The next layer to develop was the deposit layer; non-tangible book entries that could be transferred by order from one person to another.

The foundation layer has changed over time:

One of the defining themes of modern monetary history has been the death of the original foundation layer; precious metals. … as central banks chased private banks from the banknote layer … and then gradually severed the banknote layer from the gold layer. By 1971, … [b]anknotes issued by the central bank had become the foundation layer. The trend towards a cashless world is a repeat of this script, except instead of the gold layer being slowly removed it is the banknote layer.

Fintech improves the efficiency of the layer arrangement and its connections. It also adds new layers: For instance, some payments made via mobile phone effectively transfer claims on deposits. And it may circumvent layers:

In U.K., the Bank of England is considering allowing fintech companies to bypass the banking layer by offering them direct access to the bottom-most central banking layer.

In contrast, a krypto currency like bitcoin establishes a new foundation layer, on which new layers may be built:

Even now there is talk of a new layer being developed on top of the original bitcoin foundation, the Lightning network. The idea here is that the majority of payments will occur in the Lightning layer with final settlement occurring some time later in the slower Bitcoin layer.

I fully agree with this characterization. In addition to the theme emphasized by Koning—adding layers—I would also stress the theme of untying higher-level layers from lower ones: Central bank money typically is no longer backed by gold; deposits typically are not fully backed by notes; and mobile phone credits may no longer be backed by deposits. The process of untying layers relies on social conventions and trust, and it is fragile. Important questions concern the cost of such fragility, and its necessity. Fragility is not necessary when the social cost of liquidity provision at the foundation layer is negligible.


In the FAZ, molecular biologist and Tibetan monk Matthieu Ricard advises to find “happiness” (“Glück, innere Zufriedenheit”) by acquiring certain attitudes:

Wir Buddhisten, aber auch Psychologen, verstehen unter Glücklichsein keinen für sich alleinstehenden Gefühlszustand, sondern eine Gruppe von menschlichen Eigenschaften. Dazu zählen innere Freiheit, emotionale Ausgeglichenheit, altruistische Liebe, Mitgefühl. Für mich kann Glück nicht eigennützig sein. Wer sich selbst die ganze Zeit ins Zentrum stellt, fühlt sich mit der Zeit elend und ist obendrein verwundbar. Denn auch ich-zentrierte Personen kommen nicht ohne andere Menschen aus.

Um zu innerer Zufriedenheit zu gelangen, muss man den entgegengesetzten Weg gehen, und zwar die anderen Menschen ins Zentrum stellen, indem man diesen mit Wohlwollen, Großzügigkeit, Mitgefühl und Altruismus begegnet. Großzügig und freundlich zu sein, erzeugt ein Gefühl von innerer Harmonie. Diese Form von Glücklichsein nutzt sich zudem nicht ab, wie das bei den hedonistischen Freuden der Fall ist, sondern wird mit der Zeit immer stärker und verringert außerdem die Verletzlichkeit.

Daniel Quinn’s “Ishmael”

In Daniel Quinn’s “Ishmael,” a gorilla offers his perspective on human civilization and the narratives surrounding it.

Ishmael—the gorilla—characterizes the early agricultural revolution as the takeoff of the nowadays-dominant “Takers’” culture, a culture that does not only reject the hunter-gatherer and herder life of “Leaver” tribes but also finds it acceptable to eradicate the latter. The Takers reject the notion that man is part of a balanced, competitive and evolving natural system; but this rejection places humanity on a trajectory ultimately leading to self-destruction.

The gods realized that “of all the trees in the garden, only the Tree of the Knowledge of Good and Evil could destroy Adam.” (9, 6) And so they forbid Adam to taste the fruit of that tree. (He tasted anyway.) The ban constitutes a mystery for Takers. For they think of themselves as destined to rule the world, and “knowledge of good and evil is fundamentally the knowledge the rulers of the world must exercise, because every single thing they do is good for some but evil for others.” (9, 7)

According to Ishmael, the mystery is solved by noting that Genesis reflects a narrative of the Semites, a Leaver people, who experienced the expansion of the Taker culture as Cain slaughtering his brother Abel. The Hebrew later adopted the tale but could no longer make sense of it because they had adopted the Taker culture.

Ishmael makes some other points: “The Takers accumulate knowledge about what works well for things. The Leavers accumulate knowledge about what works well for people.” (10, 8) “The Takers are those who know good and evil, and the Leavers are … those who live in the hands of the gods.” (11, 6) The Leavers are in a position to evolve; they are part of the general community of life, while Takers believe that creation came to an end with man. (12, 3) “The Takers’ story is, ‘The gods made the world for man, but they botched the job, so we had to take matters into our own, more competent hand.’ The Leavers’ story is, ‘The gods made man for the world …; this seems to have worked pretty well so far, so we can take it easy and leave the running of the world to the gods.’” (12, 6)

Determinism and Free Will

In the Stanford Encyclopedia of Philosophy entry on Causal Determinism, Carl Hoefer suggests in the concluding section (Determinism and Human Action) that there is hope for those who want to believe in free will:

There is a long tradition of compatibilists arguing that freedom is fully compatible with physical determinism; a prominent recent defender is John Fischer (1994, 2012). Hume went so far as to argue that determinism is a necessary condition for freedom—or at least, he argued that some causality principle along the lines of “same cause, same effect” is required. …

Physics, particularly 20th century physics, does have one lesson to impart to the free will debate; a lesson about the relationship between time and determinism. Recall that … the fundamental theories … if they are deterministic at all, are time-symmetrically deterministic. That is, earlier states of the world can be seen as fixing all later states; but equally, later states can be seen as fixing all earlier states. …

Nor does 20th (21st) -century physics countenance the idea that there is anything ontologically special about the past, as opposed to the present and the future. In fact, it fails to use these categories in any respect, and teaches that in some senses they are probably illusory. So there is no support in physics for the idea that the past is “fixed” in some way that the present and future are not, or that it has some ontological power to constrain our actions that the present and future do not have. It is not hard to uncover the reasons why we naturally do tend to think of the past as special, and assume that both physical causation and physical explanation work only in the past present/future direction (see the entry on thermodynamic asymmetry in time). But these pragmatic matters have nothing to do with fundamental determinism. If we shake loose from the tendency to see the past as special, when it comes to the relationships of determination, it may prove possible to think of a deterministic world as one in which each part bears a determining—or partial-determining—relation to other parts, but in which no particular part (region of space-time, event or set of events, …) has a special, privileged determining role that undercuts the others. Hoefer (2002a) and Ismael (2016) use such considerations to argue in a novel way for the compatiblity of determinism with human free agency.

Pecuniary Externalities and Aggregate Demand Externalities

In Econometrica, Emmanuel Farhi and Iván Werning neatly summarize how their work on demand externalities fits in the literature.

… pecuniary externalities, which were first shown to arise when a simple friction, market incompleteness, is introduced into the Arrow–Debreu framework (see, e.g., Hart (1975), Stiglitz (1982), Geanakoplos and Polemarchakis (1985), Geanakoplos, Magill, Quinzii, and Dreze (1990)). The logic is as follows. When asset markets are incomplete and there is more than one commodity, a redistribution of asset holdings generically induces relative price changes in spot markets, in each state of the world. These relative price changes, in turn, affect the spanning properties of the limited assets that are available, potentially improving insurance. Such a pecuniary externality is not internalized by private agents. As a result, the equilibrium is generically constrained inefficient: it can be improved upon by interventions in the existing financial markets. Similar results obtain in economies with borrowing constraints that depend on prices of goods and assets, or when contracting is constrained by private information (see, e.g., Greenwald and Stiglitz (1986)). … [Other work in this literature includes Caballero and Krishnamurthy (2001), Lorenzoni (2008), Farhi, Golosov, and Tsyvinski (2009), Bianchi and Mendoza (2010), Jeanne and Korinek (2010), Bianchi (2011), Korinek (2011), Davilla (2011), Stein (2012), Korinek (2012a, 2012b), Jeanne and Korinek (2013), Woodford (2011).]

… Instead of pecuniary externalities, our theory emphasizes aggregate demand externalities. In addition to providing a new foundation for macroprudential policies, our framework, focusing on monetary policy and nominal rigidities, is well posed for the joint study of monetary and macroprudential policy.

… using a perturbation argument similar in spirit to that in Geanakoplos and Polemarchakis (1985), we show that equilibria that are not first best can be improved upon by interventions in financial markets, except in non-generic knife-edge cases. … In [the pecuniary externality] literature, the key frictions lie in financial markets themselves; in our baseline model, we assume complete markets. Pecuniary externalities rely on price movements; in our framework, price rigidities tend to negate such effects. Our results are instead driven by aggregate demand externalities that arise from nominal rigidities.

The Early Bank of England and its Contemporaries

In the Journal of Economic Literature, William Roberds reviews Christine Desan’s “Making Money: Coin, Currency, and the Coming of Capitalism” and he provides his own perspective on European monetary history.

… the transition of the Bank of England’s notes from the status of experimental debt securities (in 1694) to “as good as gold” (1833) required more than a century of legal accommodation and business comfort with their use.

Desan emphasizes England’s traditions of nominalism (as opposed to metallism) and monetary restraint as well as early experiments in monetary substitution in laying the foundations for the Bank of England’s success. Lobbying played its role, too.

Roberds discusses the experience of note issuing institutions in other countries.

At the time of the Bank’s founding, there were about twenty-five publicly owned or sponsored banks operating in Europe. These institutions are largely forgotten today; most were dissolved by the early nineteenth century and only one continues in existence, Sweden’s Riksbank. …

These banks were run by and for the merchant communities in their respective cities [Amsterdam, Genoa, Hamburg, and Venice] … The existence of the early municipal banks depended on a form of nominalism more extreme than what prevailed in contemporary England. Merchants in these “banking cities” were required by law and by custom to settle all bills of exchange (the dominant form of commercial credit) with transfers of money on the ledgers of the local public bank. The practical advantage of such a restriction was that it reduced or eliminated the possibility of settlement in the debased coins … the municipal banks’ ledger money was often seen as more reliable than the typical coin in circulation …

Most of these banks failed after getting involved in speculative episodes, hyperinflation, or political turmoil. The Bank of England was lucky.

“Kosten eines Vollgeld-Systems sind hoch (Costly Sovereign Money),” Die Volkswirtschaft, 2016

Die Volkswirtschaft 1–2 2017, December 21, 2016. HTML, PDF.

Banning inside money creation would be unnecessary, insufficient, not enforceable, and besides the point. The way forward is to grant everyone access to central bank reserves and let investors choose between reserves and deposits.

Zoroastrianism, Mandaeism, Yazidism

The NZZ runs a series on endangered religious minorities in the middle East.

Daniel Steinvorth reports about Yazidis. More on Yazidism.

Inga Rogg reports about the gnostic Mandaeans in Irak. More on Mandaeism.

Ulrich von Schwerin reports about the Zoroastrian heritage in Iran. More on Zoroastrianism.

Benjamin Todd’s “80,000 Hours”

80,000 hours, that’s how many hours we typically spent working over a lifetime, according to Benjamin Todd and the 80,000 hours team. They have published a book/ebook on how to make the best of it.

Their advice for a dream job: Look for

work you’re good at,

work that helps others,

supportive conditions: engaging work that lets you enter a state of flow; supportive colleagues; lack of major negatives like unfair pay; and work that fits your personal life.

The book discusses strategies to build a career plan, and a career. The main text closes with this summary:

Explore to find the best options, rather than “going with your gut” or narrowing down too early. Make this your key focus until you become more confident about the best options.

Take the best opportunities to invest in your career capital to become as badass as you can be. Especially look for career capital that’s flexible when you’re uncertain.

Help others by focusing on the most pressing social problems rather than those you stumble into – those that are big in scale, neglected and solvable. To make the largest contribution to those problems, consider earning to give, research and advocacy, as well as direct work.

Keep adapting your plan to find the best personal fit. Rather than expect to discover your “passion” right away, think like a scientist testing a hypothesis.

And work with a community.

In an appendix, the authors advise (potential) undergraduates to

aim for the most fundamental, quantitative option you can do i.e. one of these in the following order: mathematics, economics, computer science, physics, engineering, political science / chemistry / biology,

or otherwise,

focus on developing communication skills in philosophy, history or English.

The best choice is a combination. There is high demand for people who can understand quantitative topics and communicate clearly.

Appendix 8 contains useful career review summaries with “facts on fit” and “next steps” (see also this link for updates). For example, the authors advise that

[a]n economics PhD is one of the most attractive graduate programs: if you get through, you have a high chance of landing a good research job in academia or policy – promising areas for social impact – and you have backup options in the corporate sector since the skills you learn are in demand (unlike many PhD programs). You should especially consider an economics PhD if you want to go into research roles, are good at math (i.e. quantitative GRE score above 165) and have a proven interest in economics research.

But they warn that an Economics PhD takes a long time and

[d]oing highly open‐ended research provides little feedback which can be demotivating.

A final appendix discusses areas where people who want to help others possibly can have a large impact. As very promising areas, the authors identify

  • Biosecurity,
  • Climate change (extreme risks),
  • Factory farming,
  • Global priorities research,
  • Health in poor countries,
  • Land use reform,
  • Nuclear security,
  • Risks posed by artificial intelligence,
  • Smoking in the developing world, as well as,
  • Promoting effective altruism (the movement related to the book).

Ayn Rand in the White House

In the Washington Post, James Hohmann reports that U.S. President-elect Donald Trump and his candidate for secretary of state, Rex Tillerson, share an affection for Ayn Rand’s “objectivist” philosophy. Trump

identifies with Howard Roark, the main character in [Rand’s] “The Fountainhead”

while Tillerson prefers “Atlas Shrugged” which I reviewed here. Other prospective members of the new administration also hold objectivist views while Stephen Bannon rejects “unenlightened capitalism” a la Ayn Rand.

How Does the Blockchain Transform Central Banking?

The blockchain technology opens up new possibilities for financial market participants. It allows to get rid of middle men and thus, to save cost, speed up clearing and settlement (possibly lowering capital requirements), protect privacy, avoid operational risks and improve the bargaining position of customers.

Internet based technologies have rendered it cheap to collect information and to network. This lies at the foundation of business models in the “sharing economy.” It also lets fintech companies seize intermediation business from banks and degrade them to utilities, now that the financial crisis has severely damaged banks’ reputation. But both fintech and sharing-economy companies continue to manage information centrally.

The blockchain technology undermines the middle-men business model. It renders cheating in transactions much harder and thereby reduces the value of credibility lent by middle men. The fact that counter parties do not know and trust each other becomes less of an impediment to trade.

The blockchain may lend credibility to a plethora of transactions, including payments denominated in traditional fiat monies like the US dollar or virtual krypto currencies like Bitcoin. An advantage of krypto currencies over traditional currencies concerns the commitment power lent by “smart contracts.” Unlike the money supply of fiat monies that hinges on discretionary decisions by monetary policy makers, the supply of krypto currencies can in principle be insulated against human interference ex post and at the same time conditioned on arbitrary verifiable outcomes (if done properly). This opens the way for resolving commitment problems in monetary economics. (Currently, however, most krypto currencies do not exploit this opportunity; they allow ex post interference by a “monetary policy committee.”) A disadvantage of krypto currencies concerns their limited liquidity and thus, exchange rate variability relative to traditional currencies if only few transactions are conducted using the krypto currency.

Whether blockchain payments are denominated in traditional fiat monies or krypto currencies, they are always of relevance for central banks. Transactions denominated in a krypto currency affect the central bank in similar ways as US dollar transactions, say, affect the monetary authority in a dollarized economy: The central bank looses control over the money supply, and its power to intervene as lender of last resort may be diminished as well. The underlying causes for the crowding out of the legal tender also are familiar from dollarization episodes: Loss of trust in the central bank and the stability of the legal tender, or a desire of the transacting parties to hide their identity if the central bank can monitor payments in the domestic currency but not otherwise.

Blockchain facilitated transactions denominated in domestic currency have the potential to affect central bank operations much more directly. To leverage the efficiency of domestic currency denominated blockchain transactions between financial institutions it is in the interest of banks to have the central bank on board: The domestic currency denominated krypto currency should ideally be base money or a perfect substitute to it, directly exchangeable against central bank reserves. For when perfect substitutability is not guaranteed then the payment associated with the transaction eventually requires clearing through the traditional central bank managed clearing mechanism and as a consequence, the gain in speed and efficiency is relinquished. Of course, building an interface between the blockchain and the central bank’s clearing system could constitute a first step towards completely dismantling the latter and shifting all central bank managed clearing to the former.

Why would central banks want to join forces? If they don’t, they risk being cut out from transactions denominated in domestic currency and to end up monitoring only a fraction of the clearing between market participants. Central banks are under pressure to keep “their” currencies attractive. For the same reason (as well as for others), I propose “Reserves for All”—letting the general public and not only banks access central bank reserves (here, here, here, and here).

Banking on the Blockchain

In the NZZ, Axel Lehmann offers his views on the prospects of blockchain technologies in banking. Lehmann is Group Chief Operating Officer of UBS Group AG.

New possibilities:

  • Higher efficiency; lower cost; more robustness and simpler processes; real-time clearing;
  • no need for intermediaries; information exchange without risk of interference
  • automated “smart contracts;” automated wealth management;
  • more control over transactions; better data protection;
  • improved possibilities for macro prudential monitoring.


  • Speed; scalability; security;
  • privacy;
  • smart contracts require new contract law;
  • interface between traditional payments system and blockchain payment system.

Lehmann favors common standards and he points out that this is what is happening (R3-consortium with UBS, Hyperledger project with Linux foundation).

Related, Martin Arnold reported in the FT in late August that UBS, Deutsche Bank, Santander, BNY Mellon as well as the broker ICAP pursue the project of a “utility settlement coin.” Here is my reading of what this is:

  • The aim seems to be to have central banks on board; so USCs might be a form of reserves (base money). The difference to traditional reserves would be that USCs facilitate transactions using distributed ledgers rather than traditional clearing and settlement mechanisms. (This leads to the question of the appropriate interface between the two systems posed by Lehmann.)

But what’s in for central banks? Would this be a test before the whole clearing and settlement system is revamped, based on new blockchain technology? Don’t central banks fear that transactions on distributed ledgers might foster anonymity?

“Elektronisches Notenbankgeld ja, Vollgeld nein (Reserves for All, But no Sovereign Money),” NZZ, 2016

Neue Zürcher Zeitung, June 16, 2016. PDF, HTML. Ökonomenstimme, June 17, 2016. HTML.

  • Vollgeld seems attractive because it decouples the supply of money from intermediation. By enabling everyone to use legal tender for electronic payments, electronic base money would satisfy a need.
  • Vollgeld would prevent bank runs, at least partly; render deposit insurance unnecessary and reduce moral hazard; could help stabilize the credit cycle; and would redistribute seignorage to the central bank.
  • But these objectives can be obtained with less intrusive means.
  • Moreover, a Vollgeld system would be hard to enforce. Banks and their clients would establish new means of payment to circumvent the regulation. And in times of crisis, the central bank would feel obliged to provide liquidity assistance and bail outs.
  • The central problem is not that private money is used for transactions; it rather is that the money’s users rely on the central bank to guarantee the substitutability of private money and base money. In a democracy, the central bank cannot credibly let large parts of the payment system go under.
  • A sudden, forceful change of regime does not offer a credible way out of this trap.
  • But letting the general public access central bank reserves without abolishing private money from one day to the other may open a path towards a new arrangement where the public learns to distinguish between private and base money and where only the latter is publicly guaranteed.

Deposit Insurance: Economics and Politics

On VoxEU, Charles Calomiris and Matthew Jaremski discuss the origins of bank liability insurance. They argue that it is redistribution, not the aim to boost efficiency, which explains a lot of the action.

… there are two theoretical approaches to explaining the creation and expansion of deposit insurance. The first is an economic approach grounded in potential efficiency gains from limiting bank runs (i.e. the public interest motivation). The second is a political approach grounded in the rising power of special interest groups that favoured insurance as a means to access subsidies (i.e. the private interest motivation).

… Because insurance reduces the incentive for market discipline, it may increase fundamental insolvency risk … whether, on balance, bank liability insurance reduces or increases risk … is an empirical question. Economic theories of liability insurance only make sense on economic grounds if the gains from liquidity risk reduction tend to exceed the moral hazard or adverse selection costs from reduced market discipline.

… Political models seek to explain why liability insurance may be chosen to favour certain groups in society even when it imposes large costs on society in the form of higher systemic risk for banks. In this context, liability insurance needs to be understood as part of an equilibrium political bargain achieved by a winning political coalition. …

… we review empirical evidence about, first, which factors are shown to be instrumental in creating bank liability insurance; and second, evidence about the consequences of passing insurance … We find that political theories are much more consistent with both sets of evidence.

… the historical push for liability insurance in the US came from a coalition of small rural bankers and landowning farmers …

Worldwide, bank liability insurance remained a unique (and controversial) policy choice of the US until the late 1950s, but it spread rapidly throughout the world in recent decades …

Like the adoption of liability insurance in the US, the recent global wave of legislation creating and expanding insurance can also be traced to political influences. …

The expansion of liability insurance has been generally associated with reductions in banking system stability …

The political theories of liability insurance point to a major political advantage. It provides an effective means for a government to supply hard-to-trace subsidies to particular classes of bank borrowers … agricultural borrowers or urban mortgage borrowers …

Liability insurance can create a subsidy for banks (which they can pass through, in part, to borrowers) only if prudential regulation and supervision permit banks to take risks at the expense of the insurer. Thus, lax regulation and supervision are an important part of the political bargain that allows liability insurance to deliver subsidies to banks and targeted borrowers. …

Neo-Fisherianism Turns Mainstream

On his blog, John Cochrane offers a stripped down model and some intuition for why inflation would rise after an increase in the interest rate. The model features the usual Euler (IS) equation and a Mickey Mouse Phillips curve—inflation is proportional to consumption (or output). The intuition:

During the time of high real interest rates — when the nominal rate has risen, but inflation has not yet caught up — consumption must grow faster [the Euler equation, DN]. … Since more consumption pushes up prices, giving more inflation, inflation must also rise during the period of high consumption growth.


I really like that the Phillips curve here is so completely old fashioned. This is Phillips’ Phillips curve, with a permanent inflation-output tradeoff. That fact shows squarely where the neo-Fisherian result comes from. The forward-looking intertemporal-substitution IS equation is the central ingredient.

A slightly more plausible model with an accelerationist Phillips curve and very slowly adjusting adaptive expectations yields the following responses to an increase in the nominal interest rate:


John writes:

As you can see, we still have a completely positive response. Inflation ends up moving one for one with the rate change. Consumption booms and then slowly reverts to zero. …

The positive consumption response does not survive with more realistic or better grounded Phillips curves. With the standard forward looking new Keynesian Phillips curve inflation looks about the same, but output goes down throughout the episode: you get stagflation.

A November 2015 paper on the topic by James Bullard.

A critique by Mariana García-Schmidt and Michael Woodford in an NBER working paper. Abstract:

We illustrate a pitfall that can result from the common practice of assessing alternative monetary policies purely by considering the perfect foresight equilibria (PFE) consistent with the proposed rule. In a standard New Keynesian model, such analysis may seem to support the “Neo-Fisherian” proposition according to which low nominal interest rates can cause inflation to be lower. We propose instead an explicit cognitive process by which agents may form their expectations of future endogenous variables. Under some circumstances, a PFE can arise as a limiting case of our more general concept of reflective equilibrium, when the process of reflection is pursued sufficiently far. But we show that an announced intention to fix the nominal interest rate for a long enough period of time creates a situation in which reflective equilibrium need not resemble any PFE. In our view, this makes PFE predictions not plausible outcomes in the case of such policies. Our alternative approach implies that a commitment to keep interest rates low should raise inflation and output, though by less than some PFE analyses apply.

On his blog, Stephen Williamson addresses “Neo-Fisherian Denial.” Williamson starts with the model analyzed by Cochrane (see above) featuring a Mickey Mouse Phillips curve. He argues:

[This] NK model actually doesn’t conform to conventional central banking beliefs about how monetary policy works. What’s going on? … an increase in the current nominal interest rate will increase the real interest rate, everything else held constant. This implies that future consumption (output) must be higher than current consumption, for consumers to be happy with their consumption profile given the higher nominal interest rate. But, it turns out that this is achieved not through a reduction in current output and consumption, but through an increase in future output and consumption. This serves, through the Phillips curve mechanism, to increase future inflation relative to current inflation. Then, along the path to the new steady state, output and inflation increase.

Williamson recalls the “perils” of Taylor rules. And he addresses the critique by Garcia-Schmidt and Woodford:

Some people (e.g. Garcia-Schmidt and Woodford) have argued that Neo-Fisherian results go out the window in NK models under learning rules. As was shown above, these models are always fundamentally Fisherian in that any monetary policy rule has to somehow adhere to Fisherian logic on average – basically the long-run nominal interest rate is the inflation anchor. But there can also be learning rules that give very Fisherian results. …

Williamson also argues that other (non-Keynesian) monetary models give neo-Fisherian results as well.

A few years ago, also on his blog, Stephen Williamson argued that lowering the interest rate (by engaging in QE) might also affect the real interest rate:

… short-run liquidity effects are short-lived. Further, my work shows that there is another liquidity effect, associated with the interest bearing liquid assets, that causes the long run real rate to increase as a result of QE. … which implies lower inflation.

Further, there are other forces in play … The destruction of private sources of collateral and the shaky state of sovereign governments in parts of the world gave U.S. government debt a large liquidity premium – i.e. those things reduced real interest rates. As those effects go away over time, real rates of return will rise, shifting up the long-run Fisher relation, and reducing inflation if the Fed keeps the nominal interest rate at the zero lower bound.

In a paper, Peter Rupert and Roman Sustek dig deeper. In the abstract they write:

The monetary transmission mechanism in New-Keynesian models is put to scrutiny, focusing on the role of capital. We demonstrate that, contrary to a widely held view, the transmission mechanism does not operate through a real interest rate channel. Instead, as a first pass, inflation is determined by Fisherian principles, through current and expected future monetary policy shocks, while output is then pinned down by the New-Keynesian Phillips curve. The real rate largely only reflects consumption smoothing. In fact, declines in output and inflation are consistent with a decline, increase, or no change in the ex-ante real rate.

Addendum (May 11–12, 2016): In the abstract of their NBER working paper, Julio Garín, Robert Lester and Eric Sims write:

Increasing the inflation target in a textbook New Keynesian (NK) model may require increasing, rather than decreasing, the nominal interest rate in the short run. We refer to this positive short run co-movement between the nominal interest rate and inflation conditional on a nominal shock as Neo-Fisherianism. We show that the NK model is more likely to be Neo-Fisherian the more persistent is the change in the inflation target and the more flexible are prices. Neo-Fisherianism is driven by the forward-looking nature of the model. Modifications which make the framework less forward-looking make it less likely for the model to exhibit Neo-Fisherianism. As an example, we show that a modest and empirically realistic fraction of “rule of thumb” price-setters may altogether eliminate Neo-Fisherianism in the textbook model.

In his 2008 textbook, Jordi Gali discusses the role of the persistence of monetary policy shocks (page 51). If it is sufficiently persistent, a contractionary monetary policy shock raises the real rate (and lowers output) but decreases the nominal rate, due to the

decline in inflation and the output gap more than offsetting the direct effect [of the shock].

Views on the Fiscal Theory of the Price Level

A conference at the University of Chicago’s Becker Friedman Institute addressed the status of the Fiscal Theory of the Price Level and the theory’s implications for current policy. Slides and papers are available on the conference website. Given that the conference was meant to resuscitate research on the FTPL and that the participants were selected accordingly, many contributions appear rather mainstream.

Chris Sims worries about indeterminacy of the price level if monetary policy is constrained by the ZLB and fiscal policy is passive.

Stephen Williamson argues that it is possible, in a simple model, to separate central bank determination of inflation and the price level from fiscal policy. As he writes on his blog:

The key thing here is that the central bank determines prices and inflation without any fiscal support. If the idea you got from the FTPL is that fiscal policy is necessary to determine the price level and inflation, that’s not correct. …

So, the conclusions are:

  1. FTPL forces us to think seriously about fiscal/monetary interaction, and that’s very important. But fiscal support is not necessary for monetary policy to work, nor is it useful to think of fiscal policy determining inflation on its own – the central bank can indeed be independent.
  2. Fiscal/monetary interaction becomes really important when we start thinking about the liquidity properties of government debt.
  3. Helicopter drops? Forget it. This is not some cure-all for a low-inflation problem.
  4. QE can be harmful, as it soaks up useful collateral and replaces it with inferior assets.
  5. Neo-Fisherian denial is not good for you. Central banks that want to increase inflation need to increase nominal interest rates.

John Cochrane argues that to get the cyclical properties of inflation “right” one should focus on the discount factor in the core FTPL equation, not the primary government surplus. The discount factor might also be affected by monetary policy. See also his blog post.

Harald Uhlig remains very skeptical and points to the lack of evidence favoring the FTPL. On his first slide, he asks:

  1. What does FTPL want to be?
    – A theory that can be consistent with the data? OK
    – An equation needed to complete a system? OK
    – A theoretical or extreme possibility? OK
    – A set of predictions, which occasionally work in exotic circumstances (“Brazil”)? PERHAPS
    – A set of predictions, which help often (“Taylor coeff < 1”)? ?
    – A useful framework for practitioners? ?
    – The miracle cure for the failures of other inflation theories? ?
    – A framework for the key interplay of fiscal and monetary policy? ?
  2. Where is the “smoking gun”? What set of facts “scream” FTPL? Specific predictions?
  3. Why is sovereign default off the table? Sure, a central bank can accommodate by inflating away debt … is that all?
  4. The US, Japan, the Eurozone have a near-deflation problem (is it?). Do you advocate “irresponsible” fiscal policies to solve this?
  5. What advice would you give the sunspot-branch of macro?